Embed Size (px)
Citation preview
MOODYS.COM
26 JULY 2012
NEWS & ANALYSIS Corporates 2 » Setback for Alzheimer's Drug Is Credit Negative for Pfizer, Elan
and J&J » Brazilian Telco Oi Faces Credit Negative Ban on New Phone
Lines » Heineken Bid for F&N's Stake in APB Is Credit Positive; Thai
Beverage Bid for 50% of F&N Is Negative » Korean Telco KT's Planned Copper Cable Sale Is Credit Positive » CNOOC Acquisition Is Likely to Boost Nexen’s Credit Quality » North Sea Joint Venture with Sinopec Weakens Talisman's
Credit Quality
Infrastructure 11 » TAESA's Equity Offering Is Credit Positive » New Gas Agreement Is Credit Positive for Israel Electric
Banks 13 » Report on US Private Student Loans Is Credit Negative for
Lenders » Mexico's Niche Bank Licenses Are Credit Positive for
Non-Bank Banks » Argentina's Economic Slowdown Hurts Banks' Asset Quality
and Earnings » ECB Limit on Greek Exposure Illustrates Credit-Negative
Pressures on Banks in Stressed Euro Area Countries
CREDIT IN DEPTH Structured Finance 19
Officials in San Bernardino County, California, are considering a program that will use eminent domain to seize underwater performing mortgage loans from private-label RMBS. Although loans backed by properties in San Bernardino constitute only a small proportion of RMBS pools, the program would increase RMBS pool losses if other jurisdictions were to adopt it, because it would force losses on performing loans that could otherwise have avoided default.
RECENTLY IN CREDIT OUTLOOK In Last Monday’s Credit Outlook 24 » Table of Contents » Go to last Monday’s Credit Outlook
Discover Weekly Market Outlook, our sister publication containing Moody’s Analytics’ review of market activity, financial predictions, and calendar of economic releases.
NEWS & ANALYSIS Credit implications of current events
2 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Corporates
Setback for Alzheimer’s Drug Is Credit Negative for Pfizer, Elan and J&J
Last Monday, Pfizer Inc. (A1 stable) and Elan Corp. (B1 stable) reported disappointing results for a late-stage clinical trial involving a drug for Alzheimer’s disease called bapineuzumab. The development is credit negative for Pfizer, Elan and
plc
Johnson & Johnson (Aaa stable), the last of which is also involved in the bapineuzumab collaboration. Successful approval and marketing of bapineuzumab would help Pfizer and Johnson & Johnson offset slow growth in other parts of their businesses. But the development is even more negative for Elan, whose late-stage drug pipeline relies solely on bapineuzumab.
Despite the setback, bapineuzumab could still prove successful in three ongoing Phase III trials, and could still reach the market in several years.
Four large-scale Phase III clinical trials involving about 4,000 Alzheimer’s disease patients globally are studying bapineuzumab. The outcome reported this week relates only to the first of these four trials, which is studying patients known as ApoE4 carriers, and who carry a certain gene. Two of the remaining three Phase III trials involve ApoE4 non-carriers, a subset of the population in which bapineuzumab might be more effective based on data observed in a Phase II trial.
The collaboration involves all three companies, with Pfizer maintaining a roughly 50% economic interest and both J&J and Elan each maintaining an approximate 25% economic interest. All three companies could derive significant upside if bapineuzumab is successful, given the high need for effective treatments for Alzheimer’s disease. We estimate that annual peak sales of bapineuzumab could reach $5 billion, and perhaps significantly exceed this figure if other Alzheimer’s drugs in development are unsuccessful. This figure compares with Pfizer’s 2011 revenue of $67 billion, Johnson & Johnson’s revenue of $65 billion, and Elan’s $1.2 billion in revenue.
For both Pfizer and Johnson and Johnson, high bapineuzumab sales would offset pressure in other parts of their businesses. Pfizer, for instance, faces generic competition against arthritis drug Celebrex, a $2.5 billion drug, in 2014, and against fibromyalgia drug Lyrica, a $3.7 billion drug, in 2018. Johnson & Johnson, meanwhile, faces slower growth in various parts of its medical-device businesses because of global pricing pressure and slowing demand. Both companies face austerity measures in Europe that we expect will continue to hurt growth in pharmaceutical sales. Revenue diversity and success in other research and development areas, namely J&J’s blood thinner Xarelto and Pfizer’s vaccine Prevnar 13, help offset our concerns about the credit profiles of these two companies.
The setback is most negative for Elan because its revenue base is highly concentrated in Tysabri, a multiple sclerosis drug. Tysabri faces somewhat limited sales growth because several new products developed by competitors await marketing approval. We see bapineuzumab as Elan’s best chance at generating solid growth over the next five to 10 years. A complete failure of bapineuzumab will make Elan reliant on its earlier-stage pipeline, which includes other products for Alzheimer’s disease and which we see as having above-average failure risk owing to the earlier nature of the clinical trials.
Michael Levesque Senior Vice President +1.212.553.4093 [email protected]
NEWS & ANALYSIS Credit implications of current events
3 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Brazilian Telco Oi Faces Credit Negative Ban on New Phone Lines
Brazil’s telecommunications regulator restricted Oi S.A. (Baa2 stable) from selling new mobile-phone lines in five Brazilian states, effective last Monday. The suspension is credit negative because it could cut market share for Brazil’s largest telecommunications operator in certain regions and force the company to increase capital spending to address the service-quality issues behind the regulator’s order.
The regulator, Anatel, suspended Oi’s sales in the states of Amazonas, Amapá, Mato Grosso do Sul, Roraima and Rio Grande do Sul. These states account for 9.6% of Brazil’s population, according to the national statistics institute IBGE, and 5% of Oi’s sales of new lines, according to the company. The regulator based the suspension on a high volume of customer complaints about poor service in those states.
Oi was not the only company hit by a suspension for network problems. Anatel banned Tim Participacoes S.A. (unrated) from selling new mobile subscriptions in 18 states, including the populous Minas Gerais and Rio de Janeiro. It also banned Claro, a unit of America Movil S.A.B. de C.V. (A2 stable), from selling mobile-phone subscriptions in three states, including São Paulo. The ban will not have a negative credit effect on the broadly diversified America Movil, which operates throughout Latin America and which recently established a foothold in Europe.
For Oi, the regulator’s order will likely require an increase in capital investment from the $3 billion it expected to spend each year from 2012 to 2015. This will reduce cash flow and possibly delay the company’s deleveraging plan, which targets reported net debt/EBITDA of 2.2x by 2015, down from its guidance of 2.8x for year-end 2012.
Anatel’s order, filed on 18 July, does not indicate when it would lift the ban, although it expects mobile operators to submit investment plans and obtain respective approvals within 30 days. The companies will have to satisfy the regulator that their capital investment plans are sufficient to address service problems.
The effect on Oi will be somewhat limited by a high mobile penetration rate and low customer churn in the five states where its sales are banned. Mobile-phone penetration in the five states was 110%-136% as of last month, according to Anatel, which limits the potential for sales of new lines. Further, we estimate that Oi’s churn rate in these states is relatively low, in line with the company’s average churn of about 3.5% in Brazil as of the first quarter. We estimate a low churn rate in these states, despite customer complaints, because customers there generally have lower purchasing power compared with consumers elsewhere in Brazil, which makes them more sensitive to prices than to service quality.
The regulatory development does not affect Oi’s credit ratings because we had already expected an increase in capital spending over the next couple of years. Capital investment requirements are significant in light of increased data usage in Brazil and the telecom regulator’s focus on better service quality as Brazil prepares for a huge influx of visitors for the FIFA World Cup (soccer) in 2014 and the 2016 Summer Olympics.
With headquarters in Rio de Janeiro, Oi S.A. (formerly Brasil Telecom S.A.) and Telemar Norte Leste S.A. (Baa2 stable) are the main companies of the Oi group, Brazil's largest incumbent local exchange carrier with 17.9 million subscribers at the end of March. The company also provides wireless services, broadband services and pay TV.
Nymia Almeida Vice President - Senior Analyst +52.55.1253.5707 [email protected]
Wendell Goncalves Associate Analyst +55.11.3043.7348 [email protected]
NEWS & ANALYSIS Credit implications of current events
4 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Heineken Bid for F&N’s Stake in APB Is Credit Positive; Thai Beverage Bid for 50% of F&N Is Negative
Last Friday, Heineken N.V. (Baa1 stable) said it had offered to buy out the interests of its partner Fraser & Neave (unrated) in their joint venture, Asia Pacific Breweries (APB, unrated), for SGD5.1 billion ($4.0 billion), a 45% premium to APB’s share price.1 Heineken’s bid followed competitor Thai Beverage Public Company’s
Thai Bev’s offer to two of F&N’s principal shareholders would give it a degree of oversight over APB. Therefore, Heineken’s bid to all shareholders of F&N is a direct response to protect its interest in APB and attain a controlling stake in this strategic asset.
(Baa2 review for downgrade) binding offer to buy a 22% stake in F&N for SGD2.8 billion ($2.2 billion) two days earlier. The actions are credit positive for Heineken and credit negative for Thai Bev.
Heineken would purchase the 50% stake that F&N owns in Asia Pacific Investment Private Ltd., the parent company of APB, as well as F&N’s direct 7.3% stake (see exhibit for APB’s shareholding structure) for SGD50 a share, or about $4 billion. If F&N’s shareholders accept the offer, Heineken would have to launch a mandatory offer on the 18.4% of APB shares listed on the Singapore Exchange for a maximum cost of about $1.9 billion. Assuming that Heineken does not raise its offer, it could pay a maximum of approximately $6 billion to assume full control over APB.
1 Premium over APB’s volume weighted average price for the one-month period ended 16 July.
Annalisa Di Chiara Vice President - Senior Analyst +825.3758.1537 [email protected]
Yasmina Serghini-Douvin Vice President - Senior Analyst +33.1.53.30.10.64 [email protected]
NEWS & ANALYSIS Credit implications of current events
5 MOODY’S CREDIT OUTLOOK 26 JULY 2012
If Heineken funds the transaction with existing cash and debt, we estimate that after the deal closes its debt-to-EBITDA ratio would increase to more than 3.5x from 3.3x at year-end 2011, and that its retained cash flow to net debt would fall to the mid-to-high teens from 21.1% over the same period (these ratios include our adjustments). This would not leave leeway for operational weakness or to raise the offer price for the acquisition.
However, there are clear strategic benefits: APB gives Heineken access to growing and largely untapped beer markets across Asia, including fast-growing markets such as Indochina and Indonesia. Heineken would also be able to steer APB’s commercial strategy and capitalise on growth opportunities for its own brands. In 2011, APB generated around 30% of its beer volumes from the Heineken brand. APB will also be fully consolidated after the transaction closes, therefore its entire earnings and cash flows will be incorporated into Heineken’s accounts.
Thai Bev said it wants F&N for APB’s product portfolio, which complements its own alcoholic beverage portfolio and would diversify the company’s operations. The revenue diversity and international expansion opportunities associated with F&N’s stake in APB would be credit positives for Thai Bev, but these benefits are outweighed by the weakening of its financial profile. With $2.2
Asia Pacific Breweries Shareholder Structure
1 On 18 July 2012, Thai Bev entered into Sale & Purchase agreements with OCBC (including its insurance unit Great Eastern ) and Lee Rubber company for their collective 22% stake in F&N. Source: APB, December 2011; Moody's estimates
Asia Pacific Investment Pvte Ltd “API”
Others: Listed on Singapore Exchange
50.0%
18.4%
7.3%Direct
Investment
9.5%Direct
Investment64.8%
50.0%
Shareholders in APBHeineken: 41.9%F&N: 39.7%Public: 18.4%
OCBC, Great Eastern, Lee Rubber Company1
22%1
15%
Others:
63%
NEWS & ANALYSIS Credit implications of current events
6 MOODY’S CREDIT OUTLOOK 26 JULY 2012
billion of additional debt taken on to finance the acquisition, pro forma debt/EBITDA for the 12 months to 31 March would increase to around 3.5x from 0.6x.
A debt-funded purchase of F&N, without its investment in APB, would raise concerns about Thai Bev’s strategic direction. We view management’s use of its balance sheet to fund such a significant investment in a property and snacks business, which we see as non-core, to be inconsistent with its stated business strategy as a beverage company. We also believe this would represent a meaningful increase in management’s risk appetite. Thai Bev would be operating at a significantly higher leverage (around 3.0x-3.5x, versus less than 1.0x historically), limiting its financial flexibility to support its core beverage business and fund any future growth and international expansion opportunities.
NEWS & ANALYSIS Credit implications of current events
7 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Korean Telco KT’s Planned Copper Cable Sale Is Credit Positive
On 19 July, KT Corporation (KT, A3 negative), Korea’s largest telecom operator by revenue, said it would sell about 26,000 tons of its legacy copper cable via public bidding by the end of this year. This planned sale of copper cable will have a small, but credit positive effect on KT’s weak free cash flow. We believe the company will become more active in selling off underutilized assets to meet growing capital expenditure (capex) needs.
Copper sale. Cash proceeds from the copper cable will help KT fund its rising capex as the company migrates users to more advanced technology. Ongoing upgrading and replacement of copper cables by high-speed, fiber-optic cable for fixed-line services and growing demand for wireless services over a high-speed, fixed-line backbone make KT’s existing copper-cable networks obsolete.
Based on current copper prices, we estimate that the planned sale will add KRW150-KRW200 billion ($130-$170 million), which covers 4%-6% of the company’s expected capex for full-year 2012. We expect this to reduce KT’s estimated 2012 leverage by only 0.05x, as measured by adjusted debt/EBITDA, compared with our estimate that assumes no copper sales.
Rising capex burden. For the past two years, Korean telecom operators’ capex has soared as a result of their migration to fourth generation (4G), long-term-evolution (LTE) technology from 3G systems. The shift comes as operators in Korea try to cope with surging data traffic by deploying higher-bandwidth networks.
KT, in particular, has found it difficult to internally fund much higher levels of capex, because intensified competition with the other two market players, SK Telecom Co., Ltd. (A3 negative) and LG Uplus (unrated), and regulatory pressure to lower tariffs, have weakened its operating cash flows. In addition, rapidly expanding sales of smartphones and a buildup of receivables for installment payments on the handsets have deteriorated KT’s working capital position. As a result, the company’s free cash flow turned negative in both 2010 and 2011, and its adjusted debt/EBITDA, excluding leverage of its unrated financing subsidiary, KT Capital, rose to 2.2x in 2011 from 1.7x in 2010.
Other possible asset sales. We expect the operator to continue to conduct a strategic review of its non-core assets, including property and its remaining stock of copper cable, the monetization of which could improve the company’s financial flexibility. KT can also sell certain real estate to cover funding shortfalls. As of December 2011, the fair value of all of KT’s properties, designated as investment assets and therefore capable of monetization, amounted to approximately KRW2.5 trillion, or about 27% of the company’s total debt, excluding that of KT Capital. In 2011, KT sold part of its non-essential property for about KRW300 billion.
Serena Won Associate Analyst +852.3758.1527 [email protected]
Yoshio Takahashi Assistant Vice President - Analyst +852.3758.1535 [email protected]
NEWS & ANALYSIS Credit implications of current events
8 MOODY’S CREDIT OUTLOOK 26 JULY 2012
CNOOC Acquisition Is Likely to Boost Nexen’s Credit Quality
Last Monday, Nexen Inc. (Baa3 review for upgrade) said it had agreed to a $15.1 billion, all-cash equity offer from China’s CNOOC Limited (Aa3 stable). The agreement is credit positive for Nexen and credit neutral for CNOOC Limited. Nexen will benefit from the support of a much higher-rated parent, while CNOOC Limited expects to boost its proved reserves by 30% and increase its production by 20% through the Nexen acquisition.
Chinese companies have been highly acquisitive in Canada over the past several years, particularly in oil sands and shale gas, primarily through joint venture arrangements and acquisitions of minority interests in existing operations. This deal, however, marks by far the largest acquisition of an entire Canadian company by a Chinese entity. Sinopec’s deal with Talisman Energy, also announced Monday, is an example of a more traditional joint venture arrangement.
Nexen’s current debt of about $4.3 billion will remain outstanding. CNOOC Limited hasn’t indicated whether it will guarantee or legally assume Nexen’s debt. If not, CNOOC Limited’s ownership and strategic investment in Nexen would imply support and ratings uplift, but well below CNOOC Limited’s rating. If CNOOC Limited does not guarantee or legally assume Nexen’s, we will consider the level of financial disclosure available to determine whether we maintain a post-acquisition rating on Nexen.
Nexen’s current rating reflects its ability to generate strong cash margins from its oil-weighted product mix, its production platform of about 200,000 barrel of oil equivalent (boe) per day, and the value of its asset positions. These include ownership stakes in the Syncrude mining and upgrading operation, along with Gulf of Mexico oil discoveries, burgeoning Usan oil production in Nigeria, and Nexen’s shale gas operations in Horn River, British Columbia. Moreover, a significant portion of Nexen’s production ties to pricing based on benchmark Brent crude, which has traded strongly over the past two years and appears set to do so for at least another year.
Operating challenges and high leverage on both production and reserves negatively pressure Nexen’s credit and rating, however. Nexen’s production platform is concentrated in difficult areas, with about 50% of its 2011 production coming from the declining North Sea and the underperforming Long Lake, Alberta, steam-assisted gravity drainage operation in Canada. This has left Nexen’s cash flow susceptible to non-price-based variations.
The deal, meanwhile, has no immediate effect on the credit or issuer ratings of either CNOOC Limited or its parent, China National Offshore Oil Corporation (CNOOC Group, Aa3 stable). We affirmed both entities’ Aa3 ratings after the Nexen deal went public.
The acquisition promises to strengthen CNOOC Limited’s position as one of world’s largest independent exploration and production companies, with an expected 30% increase of proved reserves and 20% increase in production. The acquisition will also improve the diversity of CNOOC Limited’s portfolio. After the transaction, CNOOC Limited’s offshore reserves will account for 44% of its global total, compared with around 29% now. Its reserves in low-risk OECD countries would rise above 28% from about 9.3% today.
Yet although CNOOC Limited can fund most of the acquisition with cash on hand, it may incur additional debt and will likely consolidate Nexen’s debt. We expect CNOOC Limited’s adjusted debt to average daily production will rise to $13,000-$14,000 per boe, and that the transaction will reduce its retained cash flow/total debt to around 80%-100% from about 155% today. CNOOC Limited’s
Terry Marshall Senior Vice President +1.416.214.3863 [email protected]
Simon Wong Vice President - Senior Analyst +65.6398.8322 [email protected]
Kai Hu Vice President - Senior Analyst +86.10.6319.6560 [email protected]
NEWS & ANALYSIS Credit implications of current events
9 MOODY’S CREDIT OUTLOOK 26 JULY 2012
weaker financial profile would, in turn, pressure CNOOC Group’s baseline credit assessment of 5-7, equal to a global rating scale of A1-A3.
Nevertheless, our analysis of CNOOC Group’s credit factors in the very high level of expected support from the government of China (Aa3 positive), based on its strategic importance to China’s energy security and its 100% government ownership. CNOOC Limited’s rating links closely with its parent’s, and it receives some uplift from its status as CNOOC Group’s core operating subsidiary and from our expectation of government support.
NEWS & ANALYSIS Credit implications of current events
10 MOODY’S CREDIT OUTLOOK 26 JULY 2012
North Sea Joint Venture with Sinopec Weakens Talisman’s Credit Quality
Last Monday, Talisman Energy (Baa2 stable) announced it would sell 50% of its UK North Sea assets into a joint venture (JV) with Sinopec International Petroleum Exploration and Production, a subsidiary of China Petrochemical Corporation (Sinopec, Aa3 stable), for $1.5 billion in cash.
The sale is credit negative for Talisman as it reduces little of the Canadian exploration and production (E&P) company’s debt while cutting its retained cash flow (RCF) by about 15%.
We see no immediate credit implications for Sinopec, which plans some $20-$25 billion in annual capital spending over the next three to four years.
Like CNOOC’s announcement last Monday that it would acquire Nexen, the Sinopec-Talisman JV exemplifies the interest that Chinese companies have in acquiring energy assets in politically stable regions. In Sinopec’s case, the JV with Talisman reflects its past approach of finding experienced partners to help expand in unfamiliar areas.
About $2 billion of Talisman’s roughly $3 billion in operating cash flow comes from its North Sea assets, with production and cash flow split roughly 50-50 between the UK and Norway. The new JV means Talisman will give up about $500 million, or 15%, of its annual RCF. Talisman will also lose about 8% of its total production (30,000 barrels per day) and about 13% of its proved developed (PD) reserves, or around 100 million barrels.
Talisman will use $500 million of the proceeds to repurchase shares. Although the decision by Talisman to reduce its interest in the North Sea was not unexpected, the use of proceeds is: share buybacks that increase leverage are credit negative. We expect Talisman to use most of the post-share buyback proceeds to fund growth capital expenditures, with resulting cash flow likely occurring well into the future. Talisman’s RCF-to-debt metric will drop to 45% from 55%, while its leverage on production will weaken by about 10% and PD reserves will weaken by15%.
Talisman will still have strong credit quality after the sale, with a substantial reserves base, including PD reserves of 786 million barrels of oil equivalent (boe), a sizable production platform of 330,000 boe per day, geographic diversity, global scope of operations, and substantial land holdings in North America. About 35% of Talisman’s production will be liquids, with 50% of total production tied to pricing based on benchmark Brent crude (both oil and natural gas), and another 10% tied to West Texas Intermediate, the US benchmark. Brent crude today trades at high prices that appear set to continue at least over the next year.
The post-JV Talisman will also likely produce a favorable unleveraged cash margin above $35 per boe, even though 40% of its production after the JV goes into effect will come from North American natural gas, which now sells at decade-low prices. The Sinopec joint venture helps Talisman reduce its costs for abandonment liabilities to $1.4 billion from $2.9 billion as of 31 March. However, the JV’s benefits to Talisman will not fully offset its credit-related costs.
For Sinopec, meanwhile, we see no immediate rating impact. The size of the deal falls well within the company’s usual capital outlays, having spent an average $10 billion annually on overseas acquisitions from 2009-11. We expect that Sinopec will spend around $20-$25 billion annually for upstream capital spending over next three to four years. The JV will improve Sinopec’s portfolio diversification and help extend its footprint to North Sea, where it has had limited presence until now. For all this, however, the size of the JV will not significantly affect Sinopec’s credit quality.
Terry Marshall Senior Vice President +1.416.214.3863 [email protected]
Simon Wong Vice President - Senior Analyst +65.6398.8322 [email protected]
Kai Hu Vice President - Senior Analyst +86.10.6319.6560 [email protected]
NEWS & ANALYSIS Credit implications of current events
11 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Infrastructure
TAESA’s Equity Offering Is Credit Positive
Last Friday, Transmissão Aliança de Energia Elétrica S.A. (TAESA, Baa3 stable), an affiliate of the Brazilian state-run utility Companhia Energética de Minas Gerais (CEMIG, Baa3 stable), announced a primary equity offering of BRL1.53 billion ($764 million), a re-IPO, to fund its ambitious investment program. TAESA could raise an additional BRL195 million ($97 million) as part of the offering, subject to market conditions and investor demand. The new equity offering is credit positive for TAESA because it provides fresh capital to pay for its recent BRL3.7 billion ($1.85 billion) transmission acquisitions, and strengthens the company’s capital base and liquidity.
At least 30% of the proceeds will be used to pay both Cemig Geração e Transmissão (CEMIG GT, Baa3 stable), a wholly owned subsidiary of CEMIG, and CEMIG itself for the acquisition of transmission assets. TAESA will use the remaining proceeds to acquire existing and new transmission assets, and to strengthen its existing transmission network infrastructure.
TAESA recently acquired the full control of five operating transmission companies in Brazil that Spanish group Abengoa S.A. (B1 stable) previously owned. TAESA paid BRL2 billion ($1 billion), which it raised through the issuance of one-year promissory notes, to acquire Abengoa’s assets. In addition, TAESA acquired the transmission assets of CEMIG GT and CEMIG for BRL1.7 billion ($850 million). These acquisitions caused a marked deterioration in TAESA’s projected (2012-13) credit metrics and liquidity (prior to the re-IPO), diminishing interest coverage (defined as [funds from operations (FFO)] + interest/interest) to 2.87x from 3.59x; and increasing leverage by decreasing the proportion of operational cash flow to net debt (FFO/net debt) to 15.09% from 42.09%. These credit negative effects moved these metrics to the Baa3 (post-acquisitions) rating level from the previous Baa1 (pre-acquisitions) level.
The fresh capital will strengthen TAESA’s capital base and liquidity. It will also enable TAESA to pursue other potential strategic acquisitions, which would offset the initial positive capitalization effect of the re-IPO because of additional financial leverage. After the re-IPO, TAESA’s projected interest coverage will increase to 3.10x from 2.87x; and leverage will decrease as operational cash flow as a proportion of net debt increases to 18.70% from 15.09%. From a purely quantitative perspective, the improved metrics map to a Baa2 rating category. However, given TAESA’s track record of high dividend distributions and potential new acquisitions and financial leverage, it will maintain its Baa3 rating.
Alexandre De Almeida Leite Vice President - Senior Analyst +55.11.30.43.7353 [email protected]
NEWS & ANALYSIS Credit implications of current events
12 MOODY’S CREDIT OUTLOOK 26 JULY 2012
New Gas Agreement Is Credit Positive for Israel Electric
Last Sunday, Israel Electric Corporation Limited (IEC, Baa3 negative) announced that it had signed a new 15-year gas supply agreement with the Tamar Partnership (unrated), which is producing gas from the new Tamar field located in the Mediterranean Sea. The agreement is credit positive for IEC, whose existing sources of gas, which until recently fuelled some 40% of electricity production, have been severely interrupted over the past two years.
Gas imports from Egypt were repeatedly disrupted by terrorist attacks on the pipeline network following the fall of Hosni Mubarak’s regime last year, before stopping completely in April 2012 when Egyptian-government-owned gas companies Egyptian General Petroleum Corporation and Egyptian Natural Gas Holding Company cancelled the supply agreement. At the same time, production from Israel’s Mari B field, IEC’s other main source of gas, has fallen as reserves have dwindled.
With limited gas supplies, IEC has had to burn much more expensive diesel in many of its power stations (see exhibit). The company reported fuel costs of NIS9.0 billion for 2010 and NIS12.7 billion for 2011, and with a 130% year-to-year increase in the first quarter, we expect significantly higher costs for the current year. Although IEC’s regulator, the Public Utilities Authority, has allowed the company to increase tariffs a number of times (most recently to raise an additional NIS7.7 billion in revenues), the increases have been spread over three years. The resulting cash flow shortfall has exacerbated IEC’s already poor liquidity position.
Israel Electric Corporation Fuel Cost
Source: Israel Electric Corporation
New gas supplies will result in a very significant reduction in IEC’s costs and, with the benefit of tariff increases scheduled for 2013 and 2014, the company’s finances will see a marked improvement. Downward pressure on its credit profile over the past year will start to reverse, although challenges will remain, including tensions with the regulator and government, a sizable debt burden and large capital investment programme.
IEC expects supplies from the Tamar field to begin by third-quarter 2013. In addition, according to the company, Israel expects to begin importing liquid natural gas in 2013 with deployment of an offshore buoy.
IEC is the sole integrated electric utility in Israel (A1 stable), generating, transmitting, distributing and supplying substantially all of the electricity used in the country. The company is 99.85%-owned by the state and 2011 revenue was NIS24.6 billion.
0
20
40
60
80
100
120
140
160
Coal Fuel Oil Natural Gas Diesel
agor
ot/k
Wh
2011 2010
Neil Griffiths-Lambeth Senior Vice President +44.20.7772.5543 [email protected]
NEWS & ANALYSIS Credit implications of current events
13 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Banks
Report on US Private Student Loans Is Credit Negative for Lenders
Last Friday, the Consumer Financial Protection Bureau (CFPB) and the US Department of Education (ED) issued their report on the private student loan industry. One of their recommendations is that Congress consider a reexamination of the bankruptcy discharge standard that would potentially reinstate dischargeability for private student loans in bankruptcy. If enacted, it would be credit negative for student lenders, who would face higher charge-offs, lower recoveries, and lower loan origination volumes.
The Dodd Frank financial reform law mandated CFPB and ED to study the private student loan market and make appropriate recommendations. In summary, the CFPB/ED report recommended the following:
» Determining whether changes are needed to the treatment of private student loans in bankruptcy proceedings.
» Modernizing/clarifying the definition of a private student loan under the Truth-In-Lending Act, to exclude other federal education loans.
» That schools provide mechanisms for borrowers to fully understand their student loans, including both federal and private student loans.
» Determining whether additional data is needed to enhance consumer decision making and lender underwriting.
» Amending existing laws to require that institutions of higher education and private education lenders work proactively to protect and inform private student loan borrowers; this would include a requirement for school certification of private student loans to reduce over borrowing and improve product choices.
The CFPB/ED report noted no instances of historical systematic abuse of the bankruptcy code in seeking student loan discharges for private student loans in bankruptcy. Additionally, CFPB/ED were unable to find strong evidence that the 2005 changes to the bankruptcy code, which made private student loans non-dischargeable in bankruptcy, caused private student loan prices to decline or significantly increase access to them. CFPB/ED noted that if Congress concludes that the 2005 changes did not meet their overall policy goals, it would be prudent to reinstate dischargeability in bankruptcy in light of the effect on young borrowers in challenging labor market conditions.
The reinstatement of dischargeability of private loans in bankruptcy would weigh most heavily on the industry’s biggest players, particularly industry leader SLM Corp. (Ba1 stable) and to a lesser degree Wells Fargo & Company (Aa2 negative) and Discover Financial Services
As the exhibit below shows, we expect increased bankruptcy filings if private student loans are dischargeable. We think the approximately $160 million increase in net charge-offs that we estimate is manageable relative to SLM’s core earnings pre-tax income of $1.5 billion for the 12 months ended 30
(Ba1 stable) We estimate that SLM’s life of loan net charge-offs would increase by approximately $160 million (see exhibit), although we expect incremental losses would be concentrated in the first couple of years as stressed borrowers accelerated bankruptcy filings. The primary effect would be on non-cosigned student loans, as we deem it unlikely that for cosigned private loans, both the obligor and the co-obligor would declare bankruptcy.
Curt Beaudouin, CFA Vice President - Senior Credit Officer +1.212.553.1474 [email protected]
NEWS & ANALYSIS Credit implications of current events
14 MOODY’S CREDIT OUTLOOK 26 JULY 2012
June. The effect would be less significant for Wells and Discover given their relatively small proportion of total operations in private student lending.
SLM’s Bankruptcy-Related Net Charge-offs ($ Millions) Before After Difference
Non-cosigned Loans in Repayment $11,370 $11,370 $0
Bankruptcy Filing Rate 3.60% 4.30% 0.70%
Recovery Rate 20% 0% -20%
Charge-offs $409 $489 $80
Recoveries $82 $0 -$82
Net Charge-offs $327 $489 $162 Assumptions:
Dischargeability applicable to loans made both pre- and post- enactment of any new legislation.
No minimum repayment period requirement prior to dischargeability.
Loans in repayment @ 82% of total principal balance (per SLM Q2 2012 News Release).
Only non-cosigned loans in repayment affected (for cosigned loans, cosigner assumed to pay).
Bankruptcy filing rates per SLM Corp. securitization data; "After" rate of 4.3% based on pre-2005 experience.
Recovery rate assumptions per Moody's estimates.
The introduction of a minimum repayment period, as the student loan industry advocates, would address the moral hazard issue seemingly inherent in allowing private student loans to be immediately dischargeable, (i.e., borrowers take out a private loan, get their degrees and immediately declare bankruptcy to discharge the debt) and likely reduce the incremental life of loan net charge-offs associated with dischargeability. Moreover, given the high cosigner rate on new originations, the issue of dischargeability will become less significant as non-cosigned loans season and cosigned loans grow to a larger percentage of the portfolio.
Immediate dischargeability in bankruptcy could also crimp future private loan origination volumes, as lenders would likely tighten underwriting and/or re-price the product upward to take account of the higher risk.
Legislators have introduced private student loan dischargeability bills during each of the past three congressional sessions without passing it, indicating the presence of significant opposition to the measure. Nevertheless, the subject of private student loans, including their status in bankruptcy, seems to have political legs given concerns regarding mounting levels of student debt. For fiscal reasons, the federal government may be reluctant to extend such protection to federal student loans, which account for over 85% of total student loan debt.
NEWS & ANALYSIS Credit implications of current events
15 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Mexico’s Niche Bank Licenses Are Credit Positive for Non-Bank Banks
Last Friday, Mexico’s bank regulator Comisión Nacional Bancaria y de Valores (CNBV) authorized the transformation into banks of two non-bank financial intermediaries (NBFI), Unión de Crédito Nuevo Laredo, S.A. de C.V. (unrated) and Agrofinanzas, S.A. de C.V. Sofol (unrated),2 under a new limited-scope banking format. The creation of a niche bank segment is credit positive for non-bank banks, credit unions and credit cooperatives because it will foster their migration into a regulated environment and broaden their funding alternatives to include access to customer deposits, with a positive effect on their funding costs.
CNBV’s move to grant niche bank licenses to NBFI also reflects many of these entities’ difficult funding environment in the wake of the 2008 financial crisis, including Ford Credit de Mexico, S.A. de C.V. SOFOM ENR (Baa3 stable),3 Ally Credit, S.A. Sofol (MX-3 stable),4 Credito Real, S.A. Sofom ENR (unrated) and Financiera Independencia, S.A.B. Sofom ENR (unrated). Although their ability to take deposits and diversify the customer base and operations will improve the new niche banks’ financial profiles, the entities will face stiff competition from more established banks. How the new niche banks get depositors to trust their business proposition seems to be key to their success.
Turning NBFI into niche banks is also positive because it brings them under CNBV’s oversight. CNBV will oversee the operations of currently unregulated sofol (i.e. limited-scope non-bank financial institutions) and sofom (i.e. multiple-scope non-bank financial institutions), which frequently engage in consumer or car financing, payroll lending or lending to small and medium-size enterprises (SME), as well as credit unions, which have specific regional presence and aim at particular market segments. We expect CNBV’s regulatory oversight to improve corporate governance and controls, thus reducing the potential for mismanagement and opacity that have been common in this sector.
Because of their narrower business scope, niche bank licenses require less regulatory capital than full-scope banks. Niche banks require between 36-54 million inflation-indexed units of account (UDI),5 depending on the array of financial products they offer, which is equivalent to between $12.6-$18.9 million.6 By comparison, universal banks require a minimum capital investment of 90 million UDI, or nearly $32 million. We expect this relatively low capital threshold to attract at least five other NBFIs to seek a niche bank license in 2012, including credit union Union de Credito Progreso, S.A.
The new niche banks are being approved as economic activity picks up in Mexico. These entities generally have long track records and an important knowledge of their customers, most of whom have income levels well below large banks’ target market. The creation of this new bank segment, therefore, also addresses Mexican authorities’ goal to foster access to the formal banking system for the low income population, and we expect it will facilitate business development.
(B3 stable; E+/b3 stable).7 The newcomers will add to the existing 42 bank licenses operating in Mexico.
2 Unión de Crédito Nuevo Laredo, S.A. de C.V. will become Banco Bicentenario, S.A., Institución de Banca Multiple; and
Agrofinanzas, S.A. de C.V. Sofol will become Agrofinanzas, S.A., Institución de Banca Multiple. 3 Secured long-term debt rating. 4 Secured Mexican National Scale short-term debt rating. 5 UDI1 = MXN4.7599 as of 24 July per Banxico. 6 FX rate between Mexican peso and USD was MXN13.554 per US dollar as of 23 July per Banxico. 7 The bank ratings shown are the bank’s deposit rating, its standalone bank financial strength rating/baseline credit assessment,
and the corresponding rating outlooks.
David Olivares Vice President - Senior Credit Officer +52.55.1253.5705 [email protected]
NEWS & ANALYSIS Credit implications of current events
16 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Argentina’s Economic Slowdown Hurts Banks’ Asset Quality and Earnings
Last Monday, the Argentina government announced that May GDP contracted 0.5%, the first decline in 34 months, compared with growth of 0.6% in April. At the same time, the consumer confidence index published by the Torcuato Di Tella University plummeted 25% in July compared with a year earlier. The economic contraction is credit negative for Argentina’s banks because it reduces loan demand and increases delinquency ratios.
The dismal economic performance results from an erosion in competitiveness (after five years of double-digit inflation), stringent import and currency controls, and a sharp economic deceleration in Argentina’s main trade partners such as Brazil.
Banks declining loan demand and rising delinquencies are reflected in the continued increase in nonperforming loans (NPLs) in the system since November 2011, both nominally and relative to gross loans (see exhibit below). Banks’ profitability will likely suffer with the need for higher provisioning, in addition to the pressures from increasing operating costs, which are fuelled by an inflation rate that consensus estimates peg at around 25% for this year.
Argentine Banks’ Lending Quality Trends and Nonperforming Loans
Source: Central Bank of Argentina (BCRA)
Lower GDP growth will particularly affect the earnings of those banks focused on consumer lending, such as Banco de Servicios y Transacciones (Caa1 stable; E+/b3 stable),8 Banco Columbia (Caa1 stable; E+/b3 stable), Banco Cetelem Argentina (Caa1 stable; E+/b3 stable) and Banco Saenz S.A. (Caa1 stable; E+/b3 stable), which have more than half of their portfolios allocated to consumer lending and have less robust capital and reserve cushions to face unexpected credit stress. Moreover, these banks have more limited room to increase loan rates that could help them preserve profitability after the recent enforcement of lending rate caps for credit card issuers.
Consumer loans account for about half of the total loan growth reported since December 2010, mirroring an economy that has been chiefly driven by consumption. As the economy cools off and inflation remains high, increases in real wages will be lower or even negative, thereby reducing individuals’ debt servicing capacity. A 0.1% drop in the employment rate during the first quarter of
8 The ratings shown in this article are the banks’ foreign deposit rating, its standalone bank financial strength rating/baseline
credit assessment and the corresponding rating outlooks.
0%
1%
2%
3%
4%
3.5
4.5
5.5
6.5
Jan-
10
Feb-
10
Mar
-10
Apr-
10
May
-…
Jun-
10
Jul-1
0
Aug-
10
Sep-
10
Oct
-10
Nov
-10
Dec
-10
Jan-
11
Feb-
11
Mar
-11
Apr-
11
May
-11
Jun-
11
Jul-1
1
Aug-
11
Sep-
11
Oct
-11
Nov
-11
Dec
-11
Jan-
12
Feb-
12
Mar
-12
Apr-
12
May
-12
NPL
s / G
ross
Loa
ns
ARS
bill
ions
Nominal NPLs - left axis NPLs / Gross Loans - right axis
Georges Hatcherian Associate Analyst +1.212.553.2862 [email protected]
Luis Ruvira Associate Analyst +54.11.5129.2622 [email protected]
NEWS & ANALYSIS Credit implications of current events
17 MOODY’S CREDIT OUTLOOK 26 JULY 2012
2012, even if it’s a minimal decline, is the first since May 2002, and if it continues will further contribute to the pressures on household finances and reinforce the negative trend. Moreover, the persistent decline in consumer confidence, which is now at similar levels to September 2008, will restrain credit demand.
Corporate loans, around 40% of all bank loans, will also be affected, especially in terms of loan origination. Companies’ incentives to borrow are already dampened by weakening aggregate demand and continued foreign exchange and trade restrictions, which are negatively affecting production chains.
NEWS & ANALYSIS Credit implications of current events
18 MOODY’S CREDIT OUTLOOK 26 JULY 2012
ECB Limit on Greek Exposure Illustrates Credit-Negative Pressures on Banks in Stressed Euro Area Countries
Last Friday, the European Central Bank (ECB) announced that it is no longer accepting Greek government bonds or guarantees as collateral for its loans.9 As a further sign of the uncertainty about future support arrangements in the euro area and Greece’s (C) continued membership of the euro area, the ECB’s decision illustrates the credit-negative pressures on banks in all stressed euro area countries, including Portugal (Ba3 negative), Ireland (Ba1 negative), Spain (Baa3 on review for downgrade) and Italy (Baa2 negative).
Greek banks can no longer use government bond collateral to receive ECB funds; instead, they need to seek emergency liquidity assistance (ELA) from the Bank of Greece, the country’s national central bank. Losses on these ELA exposures will be borne by the Bank of Greece (and its shareholders, primarily the Greek government). Unlike losses from ECB operations, ELA-related losses are not shared among European central banks and, ultimately, their governments.
By linking any reassessment of its refusal to take Greek government-related collateral to the ongoing review of Greece’s progress under its support programme, the ECB is maintaining pressure on Greece to meet the conditions of this programme. The ECB’s decision further shows its reluctance to continue supporting Greek bank liquidity so long as Greece’s credit standing (and perhaps even its membership of the euro area) remain uncertain.
We also see the ECB’s decision as a signal of its reluctance to relieve the euro area’s fiscal authorities of their task to stabilize the finances of stressed governments. Or, as ECB President Mario Draghi put it in a media interview last Saturday: “Our mandate is not to resolve the financial problems of countries.”10 As such, the ECB’s decision is another example of the lack of clarity regarding the objectives and limits of the euro area support framework which has existed throughout the sovereign debt crisis.
For now, the ECB’s decision has no significant practical implications, as long as the Bank of Greece continues to provide ELA funds (which it does with the approval of the ECB Governing Council). ELA funds come at an only slightly higher cost than regular ECB funds. As long as the other euro area governments continue to support Greece and, by extension, its national central bank, losses on ELA exposures continue to be backstopped ultimately by Greece’s official-sector supporters including ECB shareholders.
The situation would change, however, were Greece to lose the European Union’s (EU) and International Monetary Fund’s (IMF) support and exit the euro. In such a scenario, losses on ELA lending would be borne by the Bank of Greece, backed by the Greek government, and not accrue to the ECB and its shareholders. As such, the ECB’s actions demonstrate its desire to protect its balance sheet from the consequences of a loss of EU and IMF support of Greece.
9 See ECB: Collateral eligibility of bonds issued or guaranteed by the Greek government, 20 July 2012. The ECB has in the
past temporarily stopped accepting Greek government-related collateral, see Deposit Declines and ECB's Suspension of Greek Bonds as Collateral Increase Funding Risks for Greek Banks, 5 March 2012.
10 See: ECB: Interview with Le Monde, 21 July 2012.
Alain Laurin Senior Vice President - Credit Policy +33.1.5330.1059 [email protected]
Tobias Moerschen, CFA Vice President - Research +1.212.553.2891 [email protected]
CREDIT IN DEPTH Detailed analysis of an important topic
19 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Widespread Use of Eminent Domain to Seize Mortgage Loans Would Increase Losses by 30% in Private-Label RMBS Pools
On 13 July, officials in San Bernardino County, California, met to discuss a program that will use eminent domain to seize underwater performing mortgage loans from private-label RMBS.11 Although loans backed by properties in San Bernardino constitute only a small proportion of RMBS pools, the program would increase RMBS pool losses if other jurisdictions were to adopt it, because it would force losses on performing loans that could otherwise have avoided default. The program’s “fair market value” compensation for the loans, which would reflect distressed valuations, does not incorporate an estimate of the cash flow that the performing loans would have generated.
At this point, it is too early to tell whether San Bernardino or other jurisdictions will adopt the program; however, if all 50 states were to adopt it, losses for prime jumbo RMBS pools would increase by around 30% over our current projections, resulting in higher losses on RMBS and on average three-notch downgrades to ratings on investment grade RMBS.
The program would force losses on many underwater loans that would have continued to perform. The program would force the write-down of underwater but performing loans by seizing them from trusts, leading the trusts to realize losses on loans that in many cases would have otherwise continued to perform. Exhibits 1 to 4 show the monthly rates of new delinquencies on performing loans by LTV. Jumbo loans with LTVs between 100 and 140 have become delinquent at a rate of about 1% per month, while those with LTVs higher than 140 have become delinquent at a slightly faster pace. If these rates hold, more than half of today’s performing underwater loans will still be performing five years from now.
EXHIBIT 1
Monthly Rate of New Delinquencies in 2005-2010 Vintage Jumbo RMBS, by LTV February 2010 to May 2012
Source: Moody’s Analytics, Moody’s Investors Service
11 A private firm, Mortgage Resolution Partners (MRP), created the program and marketed it to San Bernardino. Under the
program, MRP would target current borrowers with underwater loans in private-label RMBS trusts. The government would use its power of eminent domain to seize the loans of participating borrowers and compensate the RMBS trust with private investor-funded cash payments.
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Feb-
10
Mar
-10
Apr-
10
May
-10
Jun-
10
Jul-1
0
Aug-
10
Sep-
10
Oct
-10
Nov
-10
Dec
-10
Jan-
11
Feb-
11
Mar
-11
Apr-
11
May
-11
Jun-
11
Jul-1
1
Aug-
11
Sep-
11
Oct
-11
Nov
-11
Dec
-11
Jan-
12
Feb-
12
Mar
-12
Apr-
12
May
-12
> 140 LTV 120 LTV -140 LTV 100 LTV - 120 LTV 80 LTV - 100 LTV < 80 LTV
Jiwon Park Analyst +1.212.553.4951 [email protected]
Peter McNally Vice President -Senior Analyst +1.212.553.3610 [email protected]
Deepika Kothari Vice President -Senior Analyst +1.212.553.4585 [email protected]
Yehudah Forster Vice President -Senior Credit Officer +1.212.553.7995 [email protected]
CREDIT IN DEPTH Detailed analysis of an important topic
20 MOODY’S CREDIT OUTLOOK 26 JULY 2012
EXHIBIT 2
Monthly Rate of New Delinquencies in 2005-2010 Vintage Alt-A RMBS, by LTV February 2010 to May 2012
Source: Moody’s Analytics, Moody’s Investors Service
EXHIBIT 3
Monthly Rate of New Delinquencies in 2005-2010 Vintage Option ARM Mortgages by LTV February 2010 to May 2012
Source: Moody’s Analytics, Moody’s Investors Service
EXHIBIT 4
Monthly Rate of New Delinquencies in 2005-2010 Vintage Subprime RMBS, by LTV February 2010 to May 2012
Source: Moody’s Analytics, Moody’s Investors Service
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Feb-
10
Mar
-10
Apr-
10
May
-10
Jun-
10
Jul-1
0
Aug-
10
Sep-
10
Oct
-10
Nov
-10
Dec
-10
Jan-
11
Feb-
11
Mar
-11
Apr-
11
May
-11
Jun-
11
Jul-1
1
Aug-
11
Sep-
11
Oct
-11
Nov
-11
Dec
-11
Jan-
12
Feb-
12
Mar
-12
Apr-
12
May
-12
> 140 LTV 120 LTV -140 LTV 100 LTV - 120 LTV 80 LTV - 100 LTV < 80 LTV
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
Feb-
10
Mar
-10
Apr-
10
May
-10
Jun-
10
Jul-1
0
Aug-
10
Sep-
10
Oct
-10
Nov
-10
Dec
-10
Jan-
11
Feb-
11
Mar
-11
Apr-
11
May
-11
Jun-
11
Jul-1
1
Aug-
11
Sep-
11
Oct
-11
Nov
-11
Dec
-11
Jan-
12
Feb-
12
Mar
-12
Apr-
12
May
-12
> 140 LTV 120 LTV -140 LTV 100 LTV - 120 LTV 80 LTV - 100 LTV < 80 LTV
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
Feb-
10
Mar
-10
Apr-
10
May
-10
Jun-
10
Jul-1
0
Aug-
10
Sep-
10
Oct
-10
Nov
-10
Dec
-10
Jan-
11
Feb-
11
Mar
-11
Apr-
11
May
-11
Jun-
11
Jul-1
1
Aug-
11
Sep-
11
Oct
-11
Nov
-11
Dec
-11
Jan-
12
Feb-
12
Mar
-12
Apr-
12
May
-12
> 140 LTV 120 LTV -140 LTV 100 LTV - 120 LTV 80 LTV - 100 LTV < 80 LTV
CREDIT IN DEPTH Detailed analysis of an important topic
21 MOODY’S CREDIT OUTLOOK 26 JULY 2012
Determination of the fair market value of seized loans would be a challenge. The compensation for the seized loans, as the FAQs from Mortgage Resolution Partners explain,12 would be lower than the loans’ true value because it would not factor in the probability that borrowers would have continued to make payments on the loan, possibly to maturity. Compensation would be about equal to the estimated property value minus estimated foreclosure expenses and unpaid servicer advances. Estimated property values would reflect the results of other distressed sales and likely be 15% to 20% lower than open market prices.
Servicers would likely contest the seizures by challenging loan valuation. Many private-label RMBS pooling and servicing agreements (PSAs) obligate a servicer
... to represent and protect the interests of the trust in the same manner as it protects its own interests in mortgage loans in its portfolio in any claim, proceeding or litigation regarding a mortgage loan.13 (Emphasis added.)
This language would obligate a servicer to challenge the seizures to gain higher compensation. However, the RMBS trusts will have to fund the legal expenses of any challenge.
A successful expansion of the program in California or the entire US would result in increased RMBS losses. Adoption of the program in San Bernardino alone would have little impact on overall pool losses in RMBS, but widespread adoption would have a more significant impact, resulting in as much as a 30% increase in our loss projections on the loans in prime jumbo private-label RMBS.
The loans the program would likely target, first lien performing loans with LTVs higher than 120 and backed by single-family owner-occupied properties in San Bernardino county, make up only about 0.2% of the balance of all performing RMBS loans.14
12 Mortgage Resolution Partners, Frequently Asked Questions, Section Three, Question 1:
These sales [of underwater loans] occur at a significant discount to the fair value of the home because of the foreclosure discount – the market’s recognition of the cost in time, money and effort to foreclose on the homeowner and thereafter to maintain and sell the property.
13 See, for example, CWALT 2006-HY11 PSA, Section 3.01, and Banc of America Mortgage 2007-1 PSA, Section 3.01. See also Option One 2007-1 PSA, Section 3.01:
The Servicer shall service and administer the Mortgage Loans on behalf of the Trust and in the best interests of and for the benefit of the Certificateholders (as determined by the Servicer in its reasonable judgment)… in the same manner in which it services and administers similar mortgage loans for its own portfolio….
See also BNC Mortgage Loan Trust 2006-1, Aurora servicing agreement, Section 3.01: … the Servicer shall employ procedures (including collection procedures) and exercise the same care that it customarily employs and exercises in servicing and administering mortgage loans for its own account….
14 Rated RMBS Transactions with the highest exposures to properties in San Bernardino
Deal Name Asset Type
Exposure to San Bernardino (% of
Outstanding Balance) Bear Stearns Asset Backed Securities Trust 2004-HE4 Subprime 3.0% CWABS, Inc., Asset-Backed Certificates, Series 2004-ECC1 Subprime 2.5% Bear Stearns Asset Backed Securities I Trust 2004-FR1 Subprime 2.2% WaMu Mortgage Pass-Through Certificates, WMALT Series 2007-OA4 Trust Option ARM 2.1% CWALT, Inc. Mortgage Pass-Through Certificates, Series 2007-AL1 Option ARM 2.0% Source: : Moody’s Analytics, Moody’s Investors Service
CREDIT IN DEPTH Detailed analysis of an important topic
22 MOODY’S CREDIT OUTLOOK 26 JULY 2012
The effect of the program, if adopted on a wider scale, would be much larger. In California, the targeted loans constitute 6.0%, and in the US, 13.5%, of all performing RMBS. Exhibit 5 shows the proportions of performing loans with high LTVs in RMBS sectors.
EXHIBIT 5
2005-2010 Vintage RMBS Loan Status, by LTV and Asset Type As of June 2012
Source: Moody’s Analytics, Moody’s Investors Service
To assess the potential impact on RMBS pool losses of widespread adoption of the program, we reviewed 50 prime jumbo RMBS transactions issued since 2005. We focused on Jumbo RMBS because the sector contains a larger proportion of performing loans relative to other asset types and would suffer the greatest impact from adoption of the program. We used the following assumptions in determining incremental losses:
» Participating governments would seize all first lien performing loans for single-family, owner-occupied properties with an LTV greater than 100 (or 120).
» The compensation for the seized loans would amount to 80% of the loans’ property values.
We estimated the total future losses on the 50 transactions for four scenarios:
» Scenario 1: No jurisdictions adopt the program.
» Scenario 2: California adopts the program and targets all performing loans with an LTV greater than 100.
» Scenario 3: All states in the US adopt the program and target all performing loans with an LTV greater than 100.
» Scenario 4: All states in the US adopt the program and target all performing loans with an LTV greater than 120.
Depending on how many states adopted the program and on the extent of its scope, RMBS prime jumbo pool losses could increase by as much as 30% in this sample to 14.8% of outstanding balances from our current estimate of 11.3%. Exhibit 6 shows the remaining expected loss as a percentage of the remaining outstanding balance on the loans in the 50 prime jumbo RMBS in the four scenarios. The
0%
20%
40%
60%
80%
100%
Jumbo Alt-A Option ARM Subprime Total
REO Loans % FCL Loans % 90+ DPD Loans %
60 DPD Loans % 30 DPD Loans % Current Loans ( > 120 LTV) %
Current Loans ( 100 - 120 LTV) % Current Loans ( 80 - 100 LTV) % Current Loans ( < 80 LTV) %
CREDIT IN DEPTH Detailed analysis of an important topic
23 MOODY’S CREDIT OUTLOOK 26 JULY 2012
last column shows the rate at which performing loans default and become subject to a write-down pursuant to the program. In Scenario 1, losses are about 11.3% and the default rate is about 13.8%.15 In Scenario 2, losses are about 11.9% and the default rate is about 19.5%, modest increases for both. In Scenario 3, losses are about 14.8% and the default rate is about 30.9%, substantial increases for both. And, in Scenario 4, losses are about 12.9% and the default rate is about 20.4%, less dramatic increases for both.
EXHIBIT 6
Projected Impact of Program on Jumbo RMBS Loans
Program Coverage LTV Threshold for
Targeted Loans Expected Loss (% of
Outstanding Balance)
Rate that Performing Loans Default or Are Subject to Write-
Down (% of Outstanding Balance)
Scenario 1 None - 11.3% 13.8%
Scenario 2 CA 100 11.9% 19.5%
Scenario 3 All States 100 14.8% 30.9%
Scenario 4 All States 120 12.9% 20.4%
Source: Moody’s Analytics, Moody’s Investors Service
Widespread adoption of the program would lead to RMBS losses and rating downgrades. Adoption of the program would result in higher loss projections for RMBS pools and therefore ratings downgrades, the magnitude of which would depend on how many jurisdictions adopted it. Limited adoption of the program would result in few, if any, additional losses to RMBS and therefore few changes in ratings. If any of Scenarios 2, 3, or 4 were to play out, and assuming realization of the majority of program-related losses within a year or so, the increase in losses to RMBS pools, and hence the bonds, would be substantial. In that case, we would downgrade the ratings of investment grade bonds by one to three notches, corresponding to the severity of the scenarios. In the case of Scenario 3, Baa ratings would fall below investment grade. We would downgrade the ratings on non-investment grade-rated bonds, which are sensitive only to large deterioration in expected recoveries, by one notch on average if Scenarios 2, 3, or 4 were to play out.
15 We classify loans seized under the program, for this purpose, as having defaulted.
RECENTLY IN CREDIT OUTLOOK Select any article below to go to last Monday’s Credit Outlook on moodys.com
24 MOODY’S CREDIT OUTLOOK 26 JULY 2012
NEWS & ANALYSIS Corporates 2 » Walgreen, Express Scripts Pharmacy Agreement Is Credit Positive
for Both » Olin’s Acquisition of K.A. Steel Chemicals Is Credit Positive » Cequel's Sale to New Private Equity Sponsors Is Credit Negative » Rovi’s Lower Revenue and Earnings Outlooks Are Credit Negative » Grupo Posadas’s Sale of South American Hotels Is Credit Positive » GlaxoSmithKline’s Acquisition of Human Genome Sciences Is
Credit Negative » Disposal Tax on Vehicles Imported to Russia Is Credit Positive for
Russian Automakers » Ardagh Packaging’s Acquisition of Anchor Glass Is Credit Negative » Chinese Developers’ Recent Land Acquisitions Are Credit Negative » Strong Auto Sales in Indonesia Are Credit Positive for Jardine » Fortescue’s Cost Overruns and Debt-Raising Plans Are
Credit Negative
Infrastructure 17 » Korea’s Limit on Power Tariff Increase Is Credit Negative
for KEPCO
Banks 19 » A New ECB Stance on Burden-Sharing Would Be Credit Negative
for Senior Bank Creditors » US Senate Report Findings Are Credit Negative For HSBC » State Street Chooses to Leverage Up When Capital Rules Remain
Uncertain, a Credit Negative » Denmark’s Refined Impairment Rules Are Credit Positive for
Danish Banks » Israel’s Bank Competition Report Is Credit Negative for Local Banks
Sovereigns 25 » Peru’s Tax Reform Is Credit Positive » Dismissal of Tunisia’s Central Bank Governor Is Credit Negative
US Public Finance 27 » Further Job Cuts At Bank of America Are Credit Negative for
Charlotte, North Carolina
CREDIT IN DEPTH US Public Finance 29
Recent decisions to seek bankruptcy protection by two large California cities – Stockton and San Bernardino – indicate that willingness to pay debt obligations may be eroding in the US municipal market.
RATINGS & RESEARCH Rating Changes 33
Last week we upgraded University of Ontario Institute of Technology and downgraded ENI, Poste Italiane, Thermo Fisher Scientific, SUPERVALU, 10 Italian financial institutions, three Italian insurance groups, iShares ETFs, five Pakistani banks, Banca del Mezzogiorno - MedioCredito Centrale, Banca Infrastrutture Innovazione e Sviluppo, Bank of Queensland, BSI, Close Brothers Limited, Close Brothers Group, Cassa Centrale Banca-Credito Cooperativo del Nord Est, Cassa Centrale Raiffeisen dell'Alto Adige, 23 Italian sub-sovereigns, Puerto Rico Sales Tax Financing Corporation, Chicago O'Hare Airport, and 15 Italian structured finance transactions, among other rating actions.
Research Highlights 44
Last week we published on US gaming, US retail, European pharmaceutical, sovereign risk affecting European corporates, higher education, credit cards, radiation oncology, UAE banks, Lithuania, Indonesia, Italy, the State of Pennsylvania, local US governments, European structured finance, US auto ABS, and US RMBS, among other reports.
MOODYS.COM
Report: 144319
© 2012 Moody’s Investors Service, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved.
CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. (MIS”) AND ITS AFFILIATES ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY’S (“MOODY’S PUBLICATIONS”) MAY INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY’S OPINIONS INCLUDED IN MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY’S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY’S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY’S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY’S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.
ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT.
All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY’S is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. Each user of the information contained herein must make its own study and evaluation of each security it may consider purchasing, holding or selling.
NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER.
MIS, a wholly-owned credit rating agency subsidiary of Moody’s Corporation (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS’s ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading “Shareholder Relations — Corporate Governance — Director and Shareholder Affiliation Policy.”
Any publication into Australia of this document is by MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 657, which holds Australian Financial Services License no. 336969. This document is intended to be provided only to “wholesale clients” within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001.
Notwithstanding the foregoing, credit ratings assigned on and after October 1, 2010 by Moody’s Japan K.K. (“MJKK”) are MJKK’s current opinions of the relative future credit risk of entities, credit commitments, or debt or debt-like securities. In such a case, “MIS” in the foregoing statements shall be deemed to be replaced with “MJKK”. MJKK is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly owned by Moody’s Overseas Holdings Inc., a wholly-owned subsidiary of MCO.
This credit rating is an opinion as to the creditworthiness or a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors. It would be dangerous for retail investors to make any investment decision based on this credit rating. If in doubt you should contact your financial or other professional adviser.
EDITORS PRODUCTION ASSOCIATE News & Analysis: Elisa Herr and Jay Sherman Alisa Llorens
